What is Debt-to-Income Ratio and Why It’s Important

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Debt-to-income ratio (TDI) it’s how much debt you’re carrying relative to your income. In particular, it compares your monthly debt expenses against your monthly gross income (your income before taxes). This ratio shows how much of your income is “claimed” by your debts.

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How to Calculate Your Debt-to-Income Ratio

To calculate your debt-to-income ratio, you must first add up all your monthly debt payments.

That includes the obvious, like payments on personal

loans, auto loans, student loans, payday loans, credit cards (the minimum payments), and so on.

However, it also includes housing expenses. Yes, renters include their rent in their debt-to-income ratio. This is because you reliably owe rent to your landlord every month.

For homeowners, your monthly mortgage payments consisting of principal and interest are obviously included. That said, property taxes, insurance, and homeowner’s association fees are all part of your debt-to-income ratio, too, since they’re part of living in your home.

After calculating your monthly debt payment total, sum up your monthly gross income (again, your income before taxes).

This is much easier, as you usually just include your paycheck. If you have investments or other income sources that make up a substantial amount of your income, those are likely included as well.

Now that you have both numbers, divide your monthly debt total by your monthly gross income to receive a decimal ratio. If you’d like, you can multiply this decimal by 100 to arrive at a percentage.

This represents the total percentage of your income that your debt gets ahold of first.

Let’s look at an example.

Say your rent is $1,000, your car payment is $300, you have a $200 student loan payment, and you pay $100 per month on credit cards. That’s $1,600 of debt for debt-to-income purposes.

Now, imagine your salary is your only source of income. You earn $60,000 per year.

Divide $60,000 by 12 to arrive at $5,000 gross monthly income.

From there, divide $1,600 (your total monthly debt payments) by $5,000 to get 0.32.

Finally, multiply 0.32 by 100 to arrive at a debt-to-income ratio of 32%. In other words, you have to put 32% of your total income towards debt every month.

Now that you know how to calculate your debt-to-income ratio, let’s explore why you should keep an eye on it.

Why Should I Care About My Debt-to-Income Ratio?

Debt-to-income ratio plays a vital part in a couple of key areas of your finances.

Let’s look closer at why you should pay attention to your debt-to-income ratio.

Mortgages and Refinancing

It doesn’t matter whether you’re getting a mortgage to buy a home or refinancing your current mortgage to score a lower rate — home loans are massive sums of money paid back over several decades.

Thus, home lenders look at many more factors than, say, a lender like Upstart handing out a $5,000 personal loan.

One of these factors is the debt-to-income ratio. They want to see what your borrowing habits are, but they also want to make sure you have plenty of room in your budget to cover a monthly mortgage payment for years to come.

Now, home lenders actually look at two different types of debt-to-income ratios:

  • Front-end DTI
  • Back-end DTI

Front-end debt-to-income ratio is the simpler of the two. It only includes your housing-related expenses. That includes a mortgage payment if you currently have one, as well as insurance, property taxes, and homeowner’s association fees.

Lenders will calculate t